Keywords

In this chapter, we discuss the implications of the process of evolution of the industry chain for investments in the real economy and the financial market.

18.1 Investment in Real Economy: Analysis and Outlook for Industrial Investment Flows From the Perspective of China

The interregional relocation of industry chains is the process of switching directions of corporate investments among regions. Due to certain constraints such as geographical space, international production factors mainly flow in the form of capital. Generally speaking, markets that generate higher profits are more attractive to international capital. In this section, we first calculate China’s IFDI and OFDI (excluding the impact from factors such as “tax havens” and “round-tripping capital”), and then analyze the changes in the interregional and intersectoral flows of industrial investments in the Chinese market during the industry chain evolution, and hence predict the trend of future changes.

18.1.1 China’s IFDI and OFDI Face New Changes After Rapid Growth

We focus on the following characteristics of changes in the size and structure of China’s IFDI and OFDI:

IFDI to China:

  1. 1.

    China’s IFDI stocks have maintained upward trend in recent years, but the pace of growth has slowed. Data from the United Nations Conference on Trade and Development (UNCTAD)Footnote 1 shows that as of 2021, China’s IFDI stocks reached about US$2.1trn, increasing 1.9 × compared with that as of 2011. Although OFDI of most countries and regions has declined amid changes in China-US relations and the COVID-19 pandemic, China’s IFDI stocks and flows have maintained upward trends, which shows that China remains attractive to foreign companies.

  2. 2.

    On the level of countries or regions, the Asia–Pacific region is the main source of China’s IFDI, while the US and European developed countries’ trends of investments in China have diverged. Hong Kong SAR’s share in China’s IFDI has long stayed above 20%. Despite a slight decline, Japan’s share in China’s IFDI has been above 12% over the past decade. Singapore’s share has remained at 6–7%. Developed countries such as the US (8%), Germany (5%), and France still accounted for relatively high proportions of IFDI to China in 2020, but the trends have diverged, with the proportions falling for the US and the UK, but rising for Germany and France.

  3. 3.

    In terms of industry distribution, the proportion of labor-intensive, low and medium value-added manufacturing industries has declined significantly, but these industries still take up high share, while the proportion of service industries has been rising year-over-year. Low and medium value-added processing and manufacturing industries accounted for more than 30% of IFDI in all industries in 2010, and then shrunk year-over-year and dropped below 15% in 2020, resulting in a decline of the proportion of IFDI to China’s manufacturing sectors from 52% in 2010 to 27% in 2020. Given the advantage of China’s large market size, the services industry has become a new investment interest for foreign investors. In addition to leasing and commercial services and wholesale and retail, the proportion of investment in scientific research and technological services, information transmission software, and information technology services has also increased. At present, IFDI to China’s services industry has exceeded that to the manufacturing industry.

China’s OFDI:

  1. 1.

    China’s OFDI has grown rapidly, and OFDI stocks have exceeded IFDI stocks. In 2021, China’s OFDI stocks stood at US$2.6trn, up 5.1 × from 2011, ranking among the highest in the world. However, China’s OFDI flows have slowed sharply since 2015 due to multiple headwinds such as the COVID-19 pandemic and geopolitical conflicts.

  2. 2.

    On the level of countries or regions, the Asia–Pacific region has again become the key destination of China’s OFDI. Given the changes in China’s comparative advantage and the need for industrial upgrading, some Asia–Pacific countries or regions (apart from Hong Kong SAR) with rich natural or labor resources such as Australia (10% in 2020), Indonesia, Thailand, and developed countries such as the US, Canada, and Singapore are now the main destinations for China’s OFDI (Fig. 18.1). In addition to changes in internal advantages and demand, tariffs and industrial cooperation policies are also key factors affecting China’s OFDI. China’s overall OFDI in the Asia–Pacific region has increased.

    Fig. 18.1
    Two bar graph with x-axis year from 2009 to 2020 and y-axis with countries.

    Source UNCTAD, CDIS, Obis, CICC Research

    Sources of IFDI to Chinese mainland (ultimate sources after excluding the impact of round—tripping capital) and industry distribution.

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  3. 3.

    In terms of industry distribution, new-economy industries that represent industrial upgrading and labor-intensive manufacturing industries with low and medium added value are the main directions of China’s OFDI (Fig. 18.2). The proportion of China’s OFDI in industries such as scientific research and technology services, information transmission software, and information technology services has increased rapidly, and the proportion of OFDI in manufacturing industries has also expanded. If we assume that China increases OFDI at the cost of reducing domestic investment, the increase in China’s OFDI in low and medium value-added manufacturing industries in ASEAN countries may, to some extent, reflect China’s offshoring of some low and medium value-added manufacturing industries and labor-intensive industries.

    Fig. 18.2
    Two bar graph with x-axis year from 2009 to 2020 and y-axis with countries

    Source UNCTAD, CDIS, Obis, CICC Research

    OFDI destinations of Chinese mainland (ultimate destinations excluding the impact of round-tripping capital) and industry distribution.

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18.1.2 Outlook for Future Trends of China’s IFDI and OFDI

18.1.2.1 Shift of Focus from Efficiency to Both Efficiency and Security; Changes in International Relations Becoming Increasingly Important to Industry Chain Investment

Focus of industry chain investment has shifted from efficiency to both efficiency and security. In recent years, global geopolitical risks have risen markedly amid changes unprecedented in a century and the impact of the COVID-19 pandemic. Efficiency was the top priority in the globalization era. However, as the world goes down the path of deglobalization, competition between countries has intensified, so has protectionism, which makes it necessary for large economies to consider security while pursuing efficiency. Given the increasing attention to security, international relations will become a non-negligible variable affecting international investment.

Changes in international relations will affect international capital flows and evolution of the industry chain. Looking at the evolution of the international industry chain, we observe that when international relations are relatively amicable, international transaction costs such as tariffs and investment restrictions decline, facilitating cooperation and the development of international industry chains. In this case, the technological gap between developed and developing economies and amicable international relations serve as the twin engines for cooperation in the international industry chain. Taking the development of the mobile phone industry chain as an example, when the penetration rate of smartphones started to rise rapidly in 2010, Chinese companies began to grow rapidly after entering the production and supply chains of leading global companies. However, intensifying international competition has pushed up transaction costs between countries or regions, creating more obstacles to international capital flows, which also prompts the industry chain to shift from globalization to regionalization.

Watch impact of changes in international relations on China’s IFDI and OFDI. When international relations become less amicable, countries or regions may impose more restrictions on FDI, which may dampen international capital flows. In this case, China’s IFDI and OFDI can be affected and decline. Our data-based observations indicate that the growth of IFDI and OFDI between China and developed economies is more affected by changes in international relations than those between China and other developing economies.

We think industrial relations between countries may also change amid new trends in international relations. For example, the industry chain relocation from technologically advanced smaller manufacturing economies to large manufacturing economies may evolve into competition with manufacturing industries of large economies due to less amicable bilateral relations, while neutral or friendly countries and regions that have good relations with large manufacturing countries are likely to gain opportunities from the offshoring of large economies.

18.1.2.2 Outlook for China’s IFDI and OFDI Trends from Regional and Industry Perspectives

We note that the relatively unfavorable trend of international relations is a new feature against the backdrop of deglobalization, but China’s IFDI and OFDI are also affected by various factors such as the economic fundamentals, economic structure, and systems of the source and destination countries and regions. Together with the work of other scholars, we add the following considerations in the analysis of China’s IFDI and OFDI.

We need to take into account the trade dependence of the source country or region on China, and how compatible they are with the investment structure in the analysis of China’s IFDI. We believe that the higher a country’s trade dependence on China, the more challenging it is to significantly reduce investment in China in the face of negative impacts from international relations. Trade dependence refers to the proportion of a country’s imports from and exports to China in its total imports and exports. On the other hand, the degree to which the industrial structure of a source country’s investment in China matches the direction of evolution of China’s industrial structure will also affect the stability of its investment in China. This degree can be measured by the proportion of growth-oriented industries in a country’s investment in China. If a source country mainly invests in Chinese industries whose growth is set to accelerate, e.g., knowledge-intensive industries such as high-end manufacturing, its investment in China will likely trend upward as these industries expand. Conversely, investment of a source country into China is more likely to decline if its investment is concentrated in declining industries such as real estate and low-end manufacturing, in our view.

Economic and institutional factors of destination countries need to be considered in China’s OFDI. China is a developing country, and China’s OFDI has its unique features compared with those of developed countries. Based on existing studiesFootnote 2 Footnote 3 Footnote 4, we synthesize comprehensive indicators from economic and institutional dimensions to build a profile of destination countries or regions. Economic indicators include market size (per capita income), strategic resource endowment (the Human Capital Index published by the World Bank), service sector development (value added of service sector as a percentage of GDP), and communication infrastructure (number of mobile and fixed phones per 100 people). Institutional indicators include economic system, legal system, etc.

Based on the previous discussion, we analyze possible trends in source countries or regions of IFDI and destination countries or regions for OFDI within the traditional analysis framework of factors affecting international investment and factors that take into account changes in international relations. We have come to the following conclusions:

China’s IFDI: (1) From the perspective of source countries or regions: We select two indicators to depict the trend of trade dependence and the fit with investment structure. Together with changes in international relations, we believe that those with rising trade dependence on China and a good fit with its investment structures are more likely to become source countries or regions of China’s IFDI. Even if international relations are relatively unamicable, these two indicators may partially offset the negative impact on IFDI. Conversely, if both indicators are relatively weak, the proportion of IFDI may decline amid relatively unamicable international relations. (2) In terms of industry distribution: After considering China’s comparative advantages over overseas industries and the stage of evolution of the industry chain, we believe that capital-intensive industries are becoming the main targets of IFDI. In the medium-to-long term, high-end technology-intensive industries in which China has clear competitive advantages may also gradually become the main areas of investment for foreign investors, while low and medium value-added manufacturing industries and fixed asset investment-related industries may become areas where the proportion of IFDI may decline.

China’s OFDI: (1) From the perspective of destination countries or regions: We select economic and institutional indicators to portray destination countries or regions, and analyze them together with factors related to changes in international relations. If the economic and institutional conditions of destination countries or regions are more favorable, China may not substantially reduce OFDI when international relations become less amicable since these markets remain attractive. However, if the economic and institutional conditions of destination countries or regions are less favorable and international relations deteriorate, China may first reduce OFDI into such countries or regions. (2) In terms of industry distribution: Considering the growth trends and the structural changes of industries in China and destination countries or regions, China may increase OFDI in low and medium value-added manufacturing industries under the trend of optimizing industrial structure and offshoring of these industries to overseas economies. On the other hand, areas related to the fundamentals of economic development and industrial upgrading such as resources and technology manufacturing may also account for a higher proportion of China’s OFDI. Sectors in which China’s OFDI may decline mainly include fixed asset investment-related sectors such as real estate, construction, and mining (Fig. 18.3).

Fig. 18.3
Two colour tables with three columns and two rows.

Source CICC Corporation Research

Forecasts on trends of China’s IFDI and OFDI.

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18.1.2.3 Impact of International Investment Flows on Evolution of Industry Chain

International capital flows have a major impact on evolution of global industry chain. When an industry receives concentrated investment from foreign investors due to its comparative advantage at the production level, it means that the industry has sufficient development resources, and can gradually form economies of scale while expanding, achieving cost reductions, and becoming the global industry chain hub. This is clearly reflected by the sharp increase in China’s IFDI and China’s path to becoming “the world’s factory”. However, if FDI is based solely on consumption potential and only non-key links such as sales are transferred, it is not considered as relocation of industry chain hubs.

The new trend of international investment may mean that a growing number of China’s mid-range and high-end manufacturing industries are likely to become global industry chain hubs. Based on our forecasts on China’s IFDI and OFDI trends, we believe China may continue to play an important role in some capital-intensive industries, and a growing number of mid-range and high-end manufacturing industries in China may gradually gain competitive advantages and become global industry chain hubs. On the other hand, China has offshored some low and medium value-added manufacturing industries with weakening advantages or diseconomies of scale to overseas emerging markets, implying that such emerging markets are gradually forming new industry chain hubs. In this process, changes in international relations in the deglobalization era may have a negative impact on international investment. For example, although developed countries’ reduced investment in China may not alter the existing trend, the formation process of an industry chain hub in China may decelerate.

18.2 Investment in Financial Markets: Opportunities and Risks Amid the Evolution of Industry Chain

On the basis of our analysis of the real economy, this section will discuss the implications of the relocation of industry chain hubs and stages of industry chain development for capital market investment, as well as the possible opportunities and risks.

18.2.1 Implications of Industry Chain Relocation for Capital Market Investment

China upgrades industrial structures broadly amid the interregional relocation of global industry chains. After 2010, China’s manufacturing industry began to evolve from low value-added, less-technology-intensive, low-quality, and weak brands, typically in household appliances, technology hardware, and machinery. For example, the market share of Chinese smartphone brands in the domestic market was relatively low in 2010. However, as some Chinese manufacturers of smartphone components began to enter international supply chains and a number of companies became internationally competitive, Chinese smartphone equipment manufacturers caught up with the global market thanks to increases in both supply and demand. Compared with the traditional mobile phone era, China has become the global mobile phone value chain hub in the smartphones era and has gradually moved up along the value chain from low value-added assembly to high value-added design, branding, and marketing.

The formation of value chain hubs means that financial market investment is more sustainable. Relocation of an industry chain hub to a certain country means that this country enjoys comparative advantages and tends to obtain more resources for development. On the one hand, overseas competitors can be prevented from entering the domestic market, reducing the risk of competitive disadvantage or deterioration of the competitive landscape. On the other hand, overseas markets can drive new growth in demand after domestic demand peaks. Therefore, for capital market investors, industry chains that are globally competitive and may gradually become global hubs are likely to have higher perpetual growth rates, and returns from investments tend to be more sustainable. Specific capital market features include:

  1. 1.

    Relocation of industry chain hubs leads to a rising proportion of listed companies of related countries or regions in the global total market cap. For example, the US, Germany, and Japan became global leaders at different stages in the era of fossil fuel vehicles. In particular, Japan and Germany have been competing fiercely in vehicle exports since the 1990s. Toyota’s focus on the core vehicle segment, modularization, and professional outsourcing have replaced Ford’s vertical integration as the global mainstream vehicle production model. Japan and Germany also had much larger market shares in the global market caps of the auto value chain than other countries during this period. However, as global and Chinese alternative fuel vehicle (AFV) value chains began to grow and replace fossil fuel vehicle value chains since 2015, China’s AFV industry grew rapidly since 2019, with exports of passenger vehicles, auto parts, and automotive batteries rising substantially and approaching those of Japan. Meanwhile, the Tesla model has gradually become the new production model of automakers. In this context, China and the US have exhibited the trend of becoming the new hubs of the global auto industry chain. The proportion of the US and China’s auto value chains in the global total market cap has been rising since 2015 and increased substantially after 2020. The US and China now account for over 50% of the global market cap of the auto industry chain (Fig. 18.4).

    Fig. 18.4
    Left. Line graph with Global export value of passenger cars + auto parts + batteries. Right. Bar graph The market share of the automobile industry chain in major countries.

    Source UN Comtrade, CICC Research

    As the era of fossil fuel vehicles transitions to the era of alternative fuel vehicles, the gradual shift of the automobile industry chain hubs to China and the US is also reflected in their proportions of global stock market caps.

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  2. 2.

    International investors usually prefer fields with strong or improving international competitiveness. Overseas investors tend to invest in globally competitive industries based on their knowledge as they are not necessarily familiar with local industries when making investment decisions in different markets. For example, starting from 1983, foreign investors increased their exposure to the semiconductor and other electronics industries in which the Taiwan region of China enjoys strong advantages. Since 2000, their exposure to these industries has increased significantly, and these industries accounted for a much higher proportion of overseas shareholdings than other sectors. China’s high-end manufacturing industry exhibited strong resilience after US-China trade frictions arose in 2018, and foreign investors also significantly increased their exposure to high-end manufacturing industries in China such as the alternative energy and photovoltaic value chains.

  3. 3.

    Valuation premium widens amid relocation of value chain hubs. On the basis of improving the sustainability of value chain investment and increasing recognition from global investors, the formation of industry chain hubs often leads to valuation expansion. Judging from the experience of Japan’s semiconductor industry catching up with that of the US in the 1980s, the valuations of Japan’s top five semiconductor companies are positively correlated with Japan’s share in the global market and its comparative advantage over the US. When Japan’s semiconductor market share rose and exceeded that of the US, the overall valuation of Japan’s semiconductor industry expanded. When Japan’s market share peaked and then fell in the late 1980s, the valuations of related companies generally fell to normal levels. Valuations of China’s high-end manufacturing industry have also exhibited similar characteristics. As China’s auto value chain becomes more competitive globally, the valuations of Chinese auto parts and electric vehicle batteries have risen markedly compared with overseas leaders since 2020.

Differences in global competitiveness may lead to diverging market performance of different industry chains in China. The above-mentioned market characteristics during the relocation of global industry chain hubs have been reflected in important industries both globally and in China. Looking ahead, we expect China to replicate similar investment opportunities in globally competitive industry chains and enjoy more global investor attention and valuation premiums.

18.2.2 Implications of Stages of Industry Chain Development for Capital Market Investment

The life cycle of the industry chain is another indispensable factor that should be considered. Even if China enjoys global comparative advantages in the manufacturing link of an industry, the global competitiveness may not always be able to offset the loss from demand contraction, and investment in such an industry is unlikely to generate returns if the industry itself faces the risk of shrinking global demand or being replaced amid technological advances. Therefore, in addition to global competitiveness, the stage of development of an industry is also a key factor to consider in investment. We use the life cycle of an industry to illustrate this, which may determine the potential returns of financial market investment.

Optimization of the division of an industry chain’s life cycle. Traditional industrial cycle theory divides an industry into four stages: Introduction, growth, maturity, and decline. The growth stage attracts the most attention. We further divide the growth stage into early and late stages. In the early growth stage, companies tend to see high revenue growth (faster than profit growth), and capex and R&D expenses still account for a relatively high proportion of revenue. In the late growth stage, companies gradually switch from high revenue growth to high profit growth as economies of scale emerge and the competitive landscape improves, and the proportion of capex may be lower than in the early growth stage. Some industries may directly enter a recession due to shrinking demand after the maturity period, but some industries may leverage global competitiveness to expand overseas markets or create new demand through product supply innovation, thereby achieving a second growth curve (Fig. 18.5).

Fig. 18.5
Line graph with x-axis Time and y-axis demand with details Introduction, Early and late growth, Mature, Decline or second growth.

Source Wind, CICC Research

Stages of industry chain development are reflected in the life cycle of industries.

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Changes in the industrial life cycle often depend on the macro environment. China’s stock market displayed structural changes around 2010, with new-economy sectors significantly outperforming old-economy ones. The reason behind this is the change in the stage of China’s economic growth. From 2000 to 2010, China was in a stage of rapid growth in fixed asset investment and capacity expansion. Nominal fixed asset investment growth averaged more than 20% per year during the period, which helped China become the world’s largest consumer of raw materials, and also drove rapid earnings growth in the raw materials sector and a bull market in commodities. After 2010, China’s fixed asset investment growth began to slow due to overcapacity in many sectors, while consumer markets and sectors that support consumption upgrading continued to expand steadily. Therefore, resource sectors that were considered growth stocks in 2005–2007 began to be considered as mature or even declining sectors after 2010, while sectors related to consumption and industrial upgrading became growth sectors.

18.2.3 Shift of Focus From Efficiency to Security and Non-economic Factors May Lead to a Higher Risk Premium

Globalization trend is relatively positive to investment in China’s industry chain. In the era of globalization over the past four decades, China has improved efficiency under international economic and trade cooperation, and its economic strength has increased rapidly, while its enterprises come to play an increasingly important role in the global economy. Although the stock market stagnated and the average valuation declined in the early stage of economic transformation, high-quality companies representing the direction of China’s industrial upgrading and consumption upgrading still generated lucrative returns as the number and proportion of non-state-owned enterprises increased. These companies attracted attention from long-term institutional investors, and realized rising average valuation and falling average risk premium.

Shift of focus from efficiency to security may mean rising market risk premium. Under the trend of deglobalization, the shift of focus from efficiency to both efficiency and security is another major feature in the development of the global industry chain and the international division of labor, which is a new issue facing investment in the industry chain. Increasing protectionism in different countries and regions may mean more government regulation and more non-economic factors affecting the operation and layout of the industry chain. This may significantly increase the uncertainty faced by enterprises and investors, and reduce risk appetite, which may be reflected in the capital market by rising risk premium, requiring higher risk compensation for the increase in non-economic factors.

18.2.4 Outlook for Opportunities and Risks in Industry Chain Investment

18.2.4.1 The Global Competitiveness of China’s Industry Chain Comes from Four Advantages, and the Country’s Large Market Size is the Most Fundamental One

The global competitiveness of the industry chain and its life cycle are two aspects for analyzing industry chain investment, as well as dimensions that need to be considered when analyzing long-term investment opportunities. In particular, the global competitiveness of China’s industry chain is relatively unique and closely related to China’s own advantages.

Large market size remains the most important advantage on which China’s industry chain relies to achieve global competitiveness. Based on our analysis in the previous chapters and sections, we believe that China’s industrial development has four advantages, i.e., large market size, large and complete industry chain, sound infrastructure, and large amount of talent. Most developed and developing economies do not have all of these advantages. The advantage of large market size is the most fundamental factor. The large-scale production brought about by industrial transformation, together with China’s unprecedented single large market, can give full play to the unprecedented large scale of production. This is the most noteworthy aspect of China’s industrial upgrading. Large market size brings about large-scale production and demand, creating economies of scale and ultimately driving down unit production cost. This is also an important reason why most Chinese manufacturing industries have established global competitive advantages.

Economies of scale may play more important role than in the past along with the improving productivity. Economies of scale underwent three stages along with social development: (1) In the traditional agricultural society, land was the most important factor of production, and the economies of scale reflected by land use is negligible. The differential ground rent theory may be a reflection of the lack of economies of scale in land; (2) With the advent of the industrial society, economies of scale gradually emerged along with changes in the factors of production after machines became the main factor of production. The marginal cost of industrial production declined with the increase of scale within a certain range. However, such economies of scale have limits. Costs may rise if production exceeds a certain level, which may lead to diseconomies of scale. (3) In the digital era, data has become an important factor of production. Compared with the industrial economy, the economies of scale brought by data have been improved further. As platform companies’ use of data has almost no marginal cost, and the factors of production are becoming increasingly public, they have achieved economies of scope through network effects. Overall, as factors of production are gradually showing attributes of public goods, the corresponding economies of scale of social production also become stronger, and the whole society will benefit from the improvement of production efficiency. For economies with large market size, their economies of scale may also be more fully unleashed as factors of production change. From the perspective of capital market investment, industry chains with stronger economies of scale tend to have stronger profitability and continue to maintain a certain earnings growth rate after they grow to a large scale. The corresponding average valuation and the ceiling of stock market cap may also be higher than in previous eras. For example, US technology leaders have maintained high earnings growth and profitability after reaching a large scale in recent years. Their market cap as a percentage of the US stock market is much higher than that of stocks in the past, and their average valuations are also higher than those of leading companies in the industrial society.

Structurally, China’s large market size may still benefit from improving economies of scale amid deglobalization. In the era of globalization, all economies have benefited from strengthened economies of scale, and even smaller economies can benefit from economies of scale through free trade. However, the deglobalization trend is rising and the pursuit of efficiency improvement is no longer the solitary goal. Deglobalization has hindered countries from taking advantage of the international market, forcing them to rely more on the initial economies of scale formed in their domestic markets before participating in international competition. As a result, large economies are more likely to trigger economies of scale than smaller ones and enjoy new advantages in economies of scale. In this context, even if global cooperation and rising transaction costs result in global economies of scale declining or being lower than the trend in the era of globalization, China has the potential to tap the economies of scale of a large economy given its large population and market. China’s economies of scale and structural position may actually rise compared with other economies. For investors, China’s efforts to leverage its economies of scale to develop a knowledge-based economy may help some industries become global industry chain hubs and form new China-centric industry chains, which may be beneficial to the proportion of market cap, fund flows, and relative valuations of China’s industry chains.

The large market size complements other advantages, giving China a unique position in the world. (1) China’s relatively complete industry chain and industrial clusters are important advantages in attracting both multinational companies and domestic companies. China’s presence across the entire industry chain is based on market demand. Emerging economies and some developed economies with smaller aggregate sizes do not have this advantage. (2) Large market size supports large-scale infrastructure construction. China has advantages in high-speed railway infrastructure and internet coverage, enabling China to improve efficiency and reduce costs in logistics and online channels. (3) The country’s massive talent pool and growing R&D investment enable China to shift from a country with a very large population to a country with a large number of engineers. China continues to enjoy cost advantages given its well-educated labor force, laying a foundation for industrial upgrading and moving up the value chain. These four advantages enable China to enjoy a unique position in the global industry chains. Even if the labor cost advantage on which China relied in the past gradually fades, China’s dominant position in the industry chain is unlikely to be replaced.

18.2.4.2 Investment Opportunities in the Chinese Market Based on the Global Competitiveness of the Industry Chain and the Industry Life Cycle

Based on the current characteristics of China’s development, we believe that industries with the following characteristics can better leverage China’s four advantages, and are likely to be the first to establish global competitiveness and become global industry chain hubs:

  • Industries with mid-to-high technological intensity. Industries with a certain level of technological intensity can take full advantage of the cost advantage of China’s well-educated labor force, and proactive industrial policies can help eliminate the bottleneck of industrial development, giving China a distinct advantage over other developing economies. However, compared with developed countries in Europe and the US, China’s manufacturing industries mainly rely on large-scale capex, and R&D investment is insufficient. At present, China is still lagging in cutting-edge technologies, and it is unlikely for China to gain an advantage in some industries that are still in the early stages of innovation and have high technological intensity in the near term. If we use the R&D expense ratio to characterize the technological intensity of China’s industry chain, the areas in which China has an advantage are mainly those in the mid-to-high percentiles of R&D expense ratios.

  • Industries with a relatively complex industry chain. China’s large and complete industry chain has effectively reduced the procurement and logistics costs of enterprises and shortened the response time to changes in demand and technologies. This means that industries with complex industry chains can enjoy more comprehensive support in China, while most overseas economies may find it difficult to accommodate such industries. We use the input–output table to build a model of the end-product demand network to calculate the length of each industry chain so as to portray the complexity of the industry chain. The longer the industry chain, the more competitive advantage China has in the global market. If the length of a value chain is above the 50th percentile, we say China has a competitive advantage in this industry.

  • Industries with highly standardized products. Industries that can standardize production, have low product differentiation, and are highly tradable can take full advantage of China’s large market size for large-scale production and reduce costs to the lowest possible level. For example, auto, household appliances, and most machinery and equipment are relatively standardized, while production for manufacturing industries such as food, apparel, and furniture are difficult to standardize due to the large differences in consumer preferences. Therefore, manufacturing industries with a high degree of product standardization are more likely to take full advantage of China’s large market and become highly competitive in the future.

Based on our analysis in the above three dimensions, we believe that China’s industry chains that enjoy competitive advantage or are likely to become more competitive globally mainly include auto manufacturing, electrical machinery and equipment manufacturing, general equipment manufacturing, transportation equipment manufacturing, special equipment manufacturing, and computer, communication, and other electronic equipment manufacturing.

On the other hand, industry chains with global competitive advantages also need to be in a favorable position in their own industrial life cycles. Based on the previous dynamic and static analysis of the life cycles of various industries, we identify the life cycle stages of industries with a focus on whether industries are in the growth stage and whether they have a secondary growth curve after entering the maturity stage. (Fig. 18.6).

Fig. 18.6
Industrial complexity, technological intensity and standardization Graph with x-axis Industrial chain length and y-axis R&D expense ratio.

Source Wind, CICC Research

China’s industry chains with strong competitiveness in the global market in terms of industrial complexity, technological intensity, and standardization. Note R&D expense ratio is based on the average figures over 2019–2021.

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Based on the Three Criteria of Horizontal Comparative Advantage of Each Industry Chain and the Position of the Vertical Industry Life Cycle, We Divide Each Field into Four Quadrants:

  1. 1.

    Industries offering more investment opportunities: Such industries will remain as competitive as or become more competitive than they are now in the global market, and their life cycles are consistent with the macro environment and are at the growth stage. These industries are more likely to generate high and sustainable returns.

  2. 2.

    Industries offering possibly more investment opportunities while presenting more uncertainties: While it may be difficult for industries to develop strong competitiveness in the future or their competitive advantages remain weak, the industry life cycle is in line with the macro environment and is at the high growth stage. Although such industries may have high potential returns, their long-term outlook remains uncertain.

  3. 3.

    Industries offering selective investment opportunities: Industries will remain highly competitive in the global market or their competitiveness will improve further in the future. However, these industries are close to the maturity stage. It is also worth investing in if their global competitiveness is used to open up new market space and achieve a secondary growth curve. However, if these industries do not conform to the macro environment and enter the recession stage, they may offer relatively few investment opportunities.

  4. 4.

    Industries offering relatively few investment opportunities: If industries are unlikely to form strong competitiveness or its competitive advantages are weakening, and are unlikely to create a secondary growth curve after entering the maturity stage or recession stage, there may be relatively few investment opportunities in such fields.

Based on the above analysis, we have identified a number of sectors presenting more investment opportunities, including photovoltaics, lithium-ion batteries, photovoltaic equipment, lithium-ion battery equipment, alternative fuel vehicles, auto & parts, pharmaceutical outsourcing, and alternative energy materials (Fig. 18.7).

Fig. 18.7
Image contains four quadrants with x-axis Global competitiveness of industry chains and y-axis Stages of the industrial life cycle with entries Industries offering possibly more investment opportunities but with high uncertainty, Industries offering more investment opportunities, Industries offering relatively few investment opportunities and Industries offering selective investment opportunities .

Source CICC Research

Investment opportunities in China’s industry chains based on the global competitiveness of industry chains and stages at the industrial life cycle.

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18.2.4.3 Pay Attention to Potential Risks from the Shift in Focus from Efficiency to Security and the Limits to Economies of Scale

The international situation is undergoing complex and profound changes, which will affect the evolution of the industry chain and capital market investment. Accounting for the technological gap theoryFootnote 5, the relative differences in technological levels among countries will promote international division of labor and international trade. Leading countries offshore low value-added links to other countries or regions, thereby devoting more energy to high value-added links and innovation and R&D. The technology spillover effect also enables less technologically advanced economies to actively participate in the international division of work and achieve imitation, gradually narrow their gap with leading economies, and even catch up in the new technological upgrading cycle. This has also been the growth process of many Chinese manufacturing industries in the past. However, as international competition intensifies, the interregional relocation of industry chains may be interrupted, which is a risk factor that cannot be ignored. In addition, the development of some segments that could have been accelerated in cooperation will also be hindered, affecting the global competitiveness and growth cycle of industry chains.

Another potential concern for investment is that the benefits of economies of scale may come to an end; sustained technological innovation is the key. Past experiences have shown that developing China’s single market of unprecedented size is of great importance to both China’s own and global economic growth. However, we think the benefits of economies of scale will gradually dry up in the process of scaling-up, and both China and the rest of the world face downward growth pressure. As US economist Edward F. DenisonFootnote 6 pointed out, “economies of scale associated with expansion of the national market are presumably an influence tending toward a declining rate of economic growth”Footnote 7. China’s industrial upgrading is a process in which companies reduce costs, upgrade products, and enhance competitiveness through economies of scale. The benefits of scale are reflected in a growing number of products, ranging from footwear, toys, and furniture with relatively low added value to the mobile phone value chain, communication equipment, home appliances, and automobiles. Nevertheless, the benefits of such economies of scale will dry up one day. At that point, China’s economic growth may have to rely more on technological advances.

Denison also said that “changes in technology and in business organization may constantly replenish opportunities for scale economies, and probably have done so, but there is no presumption that this is sufficient to offset the basic tendency”Footnote 8. Indeed, when modern production methods have covered more and more people on the planet, especially after economies with a population as large as China have been modernized and scaled up, the pace of economic growth is decelerating and may have limits, as explained by the Club of RomeFootnote 9 in The Limits to GrowthFootnote 10. We believe that global economic growth will become increasingly dependent on, and approach the pace of technological progress. At that time, sustained technological innovation will become more critical to national and global economic growth.